The Compelling Opportunity In Emerging Growth Stocks

James L. Callinan is a portfolio manager for the Osterweis Emerging Opportunity Fund (OSTGX). The fund focuses on identifying high quality companies in emerging industries and defensible growth niches that have open ended growth potential. It seeks to buy the stocks of such companies before they are discovered or when investors are very skeptical about future prospects.

I spoke with Jim last month.

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Emerging Growth Stocks

You’ve been investing in growth companies for over 30 years. What have you learned over that time?

I’ve learned a few things. In the 1990s, you were able to buy a growth stock and if everything was in motion, the stock would stay in motion. If the earnings came through, the stock would continue to rise almost to an unreal level of valuation. But over the last 15 years, the market has been more reactive to various bits of news related to a stock so being disciplined about when you buy a stock has become more important in terms of both generating attractive long-term returns and managing risk. I still try to look for companies that have huge market and growth potential, but I have a valuation overlay. I want to buy these stocks when they’ve corrected significantly off their highs.

Are there other ways in which those lessons have changed your investment philosophy over time?

I think it is important to focus on companies that clearly look like the leaders in their markets. I identify seven or eight spaces that are really exciting and fast-growing, and then try to pick the best-positioned company in that space. At the same time, I don’t want to buy into a company that is trading at an excessive valuation so I’m looking for a company that’s attractively valued because it is really misunderstood or is somewhat mysterious because it’s a new company in a new industry.

I also believe it is important to concentrate the portfolio, and that’s something new. In the 1990s we had many, many potential investment options – there were four or five hundred IPOs a year. Now you’re only getting about 70 or 80 venture-backed IPOs a year. This means there’s a lot fewer really exciting ideas, and so the concentration makes a lot more sense.

In addition, we don’t want to be just closet indexers. We think there is real value for an active manager when it comes to investing in smaller growing companies that likely don’t have thorough, in-depth coverage by analysts and may be breaking new ground. I will say that the indexing trend has really grown as a percentage of ownership in each of the companies we own, so that a lot of movement in the stocks is really related to the flows of ETFs. In some instances outflows from ETFs may create buying opportunities for us.

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